In continuation to the Indian Government’s reform agenda, PM Modi on November 8, announced immediate demonetisation of Rs. 500 & Rs.1000 notes, in a move to reduce black money in the system, curb funding of illegal activities and address the problem of counterfeit notes. The decision to demonetise these two denominations, which constitute 86% of the total value of currency in circulation and estimated to be ~INR14tn (£ 165 bn), is expected to have major implications for India’s parallel economy. This move coincided with another historic event – the US Presidential election results, in which Trump was declared President.

What is driving the Indian markets since Nov. 9?

On November 9, the Asian markets fell in reaction to an unexpected Trump win, as they grappled with the uncertainty posed by his policies towards EMs and its impact on trade and economy and global risk appetite waned leading to massive capital flows to safe havens. However, for the Indian markets, volatility was heightened due to demonetisation which led to a steeper fall in the Indian markets as compared to the other Asian markets. BSE Sensex opened ~1600 points (6%) lower, but recovered later.

Source: Google Finance

Source: Google Finance

The markets have been undergoing correction since the announcement, mostly driven by real estate, consumption and small and mid-cap stocks. For the real estate sector, which is known to entertain cash transactions of large magnitude, prices are expected to fall as the inflated land and housing prices readjust to a more efficient price discovery for genuine buyers. Markets also reacted to an expected dip in consumption demand from the high end retail sector, for big ticket items that include white goods, autos, property, gems and jewellery, as also the lowering of consumption by the rural sector where a majority of transactions are conducted in cash. Mid and small sized stocks suffered a slide too as most of these companies rely heavily on cash for their day-to-day operations. Some of the fall could also be attributed to panic selling as investors rushed to sell stocks to overcome the unexpected liquidity crisis.

This short term crisis, however, presents a good long term buying opportunity that the investors can exploit. To understand the detailed macro story, have a look at our article from September 2016 – Why and how to invest in India.

How does demonetisation impact individual sectors?

The winners: The banking sector has been a clear winner. The increased inflow of cash from deposits will improve CASA, lower bank deposit rates and give banks access to cheap source of funds. It will also lead to lower lending rates which could boost credit demand. PSU banks are expected to benefit more as compared to private banks because of larger branch / retail franchise networks(SBI). Vehicle finance NBFCs, MFIs and gold lenders (Mahindra Finance, Muthoot Finance, Chola Investments, Mannapuram, etc.) however are expected to be temporarily negatively affected as they transact mostly in cash.

S&P BSE Bankex

(Image Source: Google Finance)

(Image Source: Google Finance)

Besides banks, the technology sector could be another beneficiary due to a change in spending patterns and the long term aspiration for individuals and companies to go cashless. Fin-tech and e-commerce companies, that include payment gateway service providers (PayUbiz payment gateway service), card companies and online retail companies could benefit from the move. Mobile wallet companies / start-ups like One97 Communications Ltd.,Mobikwik Systems, Oxigen Services etc. will also gain from people making a shift from cash to digital payments.

The Losers: However, there are certain sectors that should be clearly avoided. Real estate sector, will undergo a major correction and lead to revaluation (read devaluation) of real estate transactions / inventory. Seek companies with better corporate governance within the sector for long term gains. Related industries like construction will be hard hit as companies struggle to pay daily wage labourers. Cement, which is used primarily for housing construction, will face trouble too from declining demand in organized real estate (Ambuja Cements)

Consumer discretionary sector is another loser. Gold and jewellery consumption, a prime beneficiary of black money transactions, will be the most hit (TBZ). People are also expected to cut down investments in durables like consumer electronics, automobiles and luxury items. Sales of cigarettes mostly done in cash, will suffer too (ITC), food and beverage stocks like Coffee Day, FMCGs like HUL are also likely to be impacted, but customer loyalty might be able to cushion their fall.

Some of the major ADR losers since demonetisation are listed below:

Tata Motors (TTM)

(Image Source: Google Finance)

(Image Source: Google Finance)

ICICI Bank Ltd. (IBN)

(Image Source: Google Finance)

(Image Source: Google Finance)

HDFC Bank Ltd. (HDB)

(Image Source: Google Finance)

(Image Source: Google Finance)

Long term picture seems rosy despite current hiccups

This step, far bigger than the GST reform, will cause a temporary volatility in the market and might be negative for the economy in the short term as a slowdown in the velocity of business and consumption demand (primarily from loss of ‘sin money’ which will become worthless) might create a temporary dip in the GDP (black money is estimated to be ~10% of the GDP). However, it will lead to improved transparency and tax compliance which will lead to long term structural benefits like higher financial inclusion and rising national productivity. It will pay the investors to see the forest for the trees, as reforms related to corruption and taxes(GST) will help improve India’s image, lead to a ratings upgrade and drive global investments in the long term. The investors can also exploit the short term volatility by picking up fundamentally strong companies at reasonable prices. India Investors should steer clear of these sectors for now: Real Estate, NBFCs, Construction, Cement, and Consumer Discretionary. The moolah lies in banking and technology sectors

Foreign investors are not entirely excluded from accessing these potential returns, as ADRs, GDRs, ETFs and mutual funds allow for investment in Indian companies from abroad, in many markets across the globe. You can track real-time, comprehensive and personalised news for the Indian ADRs on CityFALCON.

Note: It is not my intent to discuss political views on the subject of demonetisation. This article is written solely to discuss my views on the economic impact of demonetisation and related investment ideas from a stock market perspective.

 




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